Risk Part 2 – Equity Diversity

20 Sep 2013 21:20
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A fact with Dividend Growth Investing is that it is 100% invested in stock equities. Though historical stock performance can provide some patterns it cannot accurately predict the future on how stock markets perform. The lack of uncertainty exposes you to some level of risk if stocks perform poorly.

Some might argue that while investment cost is a concern it is not the top priority for DGI. As long as a portfolio continues to receive income and income growth through dividends the downward stock prices are not a major impact. Or more simply…”Why do I care if equity prices rise or fall as long as I keep getting my dividend checks?” While this may be a valid statement it does not address unforeseen risks.

No one has a crystal ball and there are too many external factors that can influence the stock market. For example, what if a drastically higher corporate tax is applied by the I.R.S? The increased tax expense may require companies to decrease dividend payments and invest the capital back into the company to sustain growth and compensate for the excessive taxation. Of course this is not a real scenario but only one of many what-if topics that could derail your investments and DGI strategy.

As much as I enjoy, support, and strongly believe in the benefits of DGI I would be wrong to say that it should be your only investment. Much like stocks, you should diversify your equity investments to reduce risk and preserve equity. Of course if you are a young investor starting out this probably is not feasible as you have limited financial savings but equity preservation should be a part of your long term investing plan.

Examples of some investments you can use to diversify your equity:

Cash

  • Bank Savings Account
  • Bank Certificate of Deposit
  • Money Market Account

Bonds

  • U.S. Government Debt
  • Foreign Government Debt
  • U.S. Corporate Debt
  • Foreign Corporate Debt
  • Municipal Bonds

Hard Investments

  • Real Estate / Rental Property
  • Precious Metals

Other Investments

  • Annuities
  • Preferred Stocks

I do not recommend investing in all the items above but simply listed potential alternatives. Never invest blindly, if you wish to diversify then investigate each one and become well versed on the good & bad or talk to a financial analyst if you do not have the time.

The next question is if you diversify how much? I do not believe there is one single answer to this question. It depends on your personal situation. The best I can share is my situation where I have 7% in cash, 78% in stocks and 15% in bonds. Since I am in my mid-forties I believe I can withstand a decent level of exposure to risk and still have enough time to recover. My current house has 90% equity and should be paid off in 3 years so I see no reason to add rental property. Additionally, I am one of the lucky few who will receive a small pension which provides further security in later years so I feel extremely comfortable maintaining my 78% stock exposure up to retirement.

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